Pricing Business Loans One of the most difficult

Pricing Business Loans • One of the most difficult tasks in lending is deciding how to price a loan ▫ Lender wants to charge a high enough interest rate to ensure each loan will be profitable and compensate the lending institution for the risks involved • The Cost-Plus Loan Pricing Method

Pricing Business Loans (continued) • The Price Leadership Model

วธการแบบดงเดม (Traditional Method)ประกอบดวยวธการประเมนสนเช อ 3 วธ ไดแก : The Judgmental Method หรอ The Expert Systems Method The Rating Method The Credit Scoring Method

Credit Analysis and the Job of a Credit Analyst – Assess the financial performance (past, current, and projected or pro forma) of credit applicants to determine their creditworthiness. Four key areas in a credit memo that a credit analyst would construct in their analysis: 1. Management (who are we lending to? ) 2. Company Operations (what do they do and how do they do it? ) 3. Industry (what does the company face? ) 4. Financial Performance (what is quantitative ability to repay? ) Chapter 10 42

Steps in the Lending Process 1. Finding Prospective Loan Customers 2. Evaluating a Customer’s Character and Sincerity of Purpose 3. Making Site Visits and Evaluating a Customer’s Credit Record 4. Evaluating a Prospective Customer’s Financial Condition 5. Assessing Possible Loan Collateral and Signing the Loan Agreement 6. Monitoring Compliance with the Loan Agreement and Other Customer Service Needs

Credit Analysis: What Makes a Good Loan? 1. ▫ Is the Borrower Creditworthy? The Cs of Credit Character ▫ Specific purpose of loan and serious intent to repay the loan ▫ Capacity ▫ Legal authority to sign binding contract ▫ Cash ▫ Ability to generate enough cash to repay loan ▫ Collateral ▫ Adequate assets to support the loan ▫ Conditions ▫ Economic conditions faced by borrower ▫ Control ▫ Does loan meet written loan policy and how would loan be affected by changing laws and regulations

Credit Analysis: What Makes a Good Loan? (continued) 2. Can the Loan Agreement Be Properly Structured and Documented? ▫ ▫ This requires drafting a loan agreement that meets the borrower’s need for funds with a comfortable repayment schedule ▫ If a major borrower gets into trouble because of an inability to service a loan, the lending institution may find itself in trouble Proper accommodation of a customer may involve lending more or less money than requested over a longer or shorter period

Credit Analysis: What Makes a Good Loan? (continued) 3. Can the Lender Perfect Its Claim against the Borrower’s Earnings and Any Assets That May Be Pledged as Collateral? ▫ Reasons for Taking Collateral ▫ If the borrower cannot pay, the pledge of collateral gives the lender the right to seize and sell those assets ▫ It gives the lender a psychological advantage over the borrower ▫ Types of Collateral ▫ ▫ ▫ Accounts Receivables Factoring Inventory Real Property Personal Guarantees

EXHIBIT 16– 1 Safety Zones Surrounding Funds Loaned in Order to Protect a Lender

TABLE 16– 4 Sources of Information Frequently Used in Loan Analysis and Evaluation by Lenders and Loan Committees

Financial Ratio Analysis of a Customer’s Financial Statements • • Information from balance sheets and income statements is typically supplemented by financial ratio analysis Critical areas of potential borrowers loan officers consider: 1. Ability to control expenses 2. Operating efficiency in using resources to generate sales 3. Marketability of product line 4. Coverage that earnings provide over financing cost 5. Liquidity position, indicating the availability of ready cash 6. Track record of profitability 7. Financial leverage (or debt relative to equity capital) 8. Contingent liabilities that may give rise to substantial claims in the future

Parts of a Typical Loan Agreement • • The Promissory Note Loan Commitment Agreement Collateral Covenants ▫ ▫ Affirmative Negative • Borrower Guaranties or Warranties • Events of Default

Loan Review 1. Carrying out reviews of all types of loans on a periodic basis 2. Structuring the loan review process ▫ ▫ ▫ Record of borrower payments Quality and condition of collateral Completeness of loan documentation Evaluation of borrower’s financial condition Assessment as to whether the loan fits with the lender’s loan policies 3. Reviewing Largest Loans Most Frequently 4. Conducting More Frequent Reviews of Troubled Loans 5. Accelerating the Loan Review Schedule if Economy or Industry Experiences Problems

Loan Workouts • Loan workout – the process of recovering funds from a problem loan situation • Warning Signs of Problem Loans 1. 2. 3. 4. 5. 6. 7. 8. Unusual or unexpected delays in receiving financial statements Any sudden changes in accounting methods Restructuring debt or eliminating dividend payments or changes in credit rating Adverse changes in the price of stock Losses in one or more years Adverse changes in capital structure Deviations in actual sales from projections Unexpected or unexplained changes in deposits

TABLE 16– 5 Warning Signs of Weak Loans and Poor Lending Policies

Loan Workouts (continued) • What steps should a lender take when a loan is in trouble? 1. 2. 3. 4. 5. 6. 7. 8. ▫ Do not forget the goal: Maximize full recovery of funds Rapid detection and reporting of problems is essential Loan workout should be separate from lending function Should consult with customer quickly regarding possible options Estimate resources available to collect on loan Conduct tax and litigation search Evaluate quality and competence of management Consider all reasonable alternatives Preferred option: Seek a revised loan agreement